How Do Retail Prices React to Minimum Wage Increases?
A textbook consequence of an industry-wide cost shock is that it will be passed on
to consumers through an increase in prices. The minimum wage offers a compelling
natural experiment of such a cost shock, particularly among industries that employ low-
wage labor.
We assess the effect of recent minimum wage increases on restaurant prices,
using specific item prices collected by the Bureau of Labor Statistics (BLS). We find that
price responses follow textbook expectations in several dimensions. First, restaurant
prices rise, by amounts that are broadly consistent with the modest costs imposed by
minimum wage increases. Second, prices respond rather quickly, within a six-month window around the wage increase. Third, price increases are greater among fastfood
outlets and in low-wage locations, where minimum wage increases would be expected to
have greater effects on costs.
But other elements of the price response are more complicated. A restaurant does
not raise all of its prices by amounts reflecting the costs of minimum wage increases
(from 0.3 to 1.8 percent, depending on outlet type and location). Rather, it raises fewer
prices (up to 25 percent of its items), but by 3 to 6 percent, on average. That response
suggests that there may be some item-specific costs to changing price, or that demand
elasticities vary across items. Furthermore, we find that items at certain prices (such as
fastfood items with prices ending in 99 cents) are less likely to be raised in the face of a
minimum wage increase, and that outlets with recent price reviews are less likely to
respond to minimum wage changes.
This pattern of restaurant price responses relates closely to notions of price
stickiness. As has been known since Keynes, the dynamics of a price change can be
complicated; in particular, prices may not react instantaneously to cost changes. Figure 1
exemplifies the issue; it plots monthly changes in the Food Away from Home component
of the Consumer Price Index (CPI) from 1995 to 1997, along with Producer Price Indexes
for two key restaurant inputs: pork and ground beef. While input prices are quite volatile,
the Away from Home CPI moves slowly and methodically. Figure 1 suggests that prices
may respond very slowly to cost changes, and the literature suggests conditions under
which prices may not react at all. We present further evidence of sluggish price changes
in our analysis below and relate those findings to other firm level results on nominal price
rigidity. We then contrast the usual co-movements of prices and costs with the rapid and
full response to a large, national, well-identified cost shock like the minimum wage.
http://www.chicagofed.org/digital_assets/publications/working_papers/2000/wp2000_20.pdf